David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Shenzhen Jufei Optoelectronics Co., Ltd. (SZSE:300303) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Shenzhen Jufei Optoelectronics's Net Debt?

As you can see below, at the end of March 2024, Shenzhen Jufei Optoelectronics had CN¥681.2m of debt, up from CN¥480.8m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.90b in cash, leading to a CN¥1.22b net cash position.

How Strong Is Shenzhen Jufei Optoelectronics' Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Jufei Optoelectronics had liabilities of CN¥1.86b falling due within a year, and liabilities of CN¥490.9m due beyond that. On the other hand, it had cash of CN¥1.90b and CN¥1.58b worth of receivables due within a year. So it can boast CN¥1.13b more liquid assets than total liabilities.

It's good to see that Shenzhen Jufei Optoelectronics has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Shenzhen Jufei Optoelectronics has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Shenzhen Jufei Optoelectronics grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shenzhen Jufei Optoelectronics's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shenzhen Jufei Optoelectronics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Shenzhen Jufei Optoelectronics produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Jufei Optoelectronics has CN¥1.22b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 33% over the last year. When it comes to Shenzhen Jufei Optoelectronics's debt, we sufficiently relaxed that our mind turns to the jacuzzi. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Shenzhen Jufei Optoelectronics (at least 1 which is significant) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com